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Unbalanced Deflation And Its Consequences

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"Unbalanced Deflation And Its Consequences"

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Something that I think often isn’t reported right in the business press is the meaning of real estate prices. All else being equal, there’s no reason to think of a market in which homes are expensive as “good” and one in which homes are cheap as “bad.” A home is a useful thing to get your hands on, so when homes are cheap it’s easier for people to get their hands on something useful. That’s a good thing.

The problem we’re dealing with is something more specific. People took out loans to buy expensive homes, and now that the homes have become cheaper that’s left the country with more debt. A Calculated Risk chart illustrates this:

The problem here is really with the expensive mortgages, not the cheap houses. Over the long run, an equilibrium in which houses are cheap and therefore mortgages are cheap too would be an excellent one to reach. The trouble is that when you try to reach this equilibrium through liquidation rather than inflation you get this unbalanced transition period in which the ratio of debts to assets goes up. And that, by the same token, is why monetary stimulus is preferable to trying to force people to swallow nominal wage cuts. Either reduces the cost of hiring a new worker, but one deflates debts along with incomes and the other is unbalanced and causes long painful transitions. Unfortunately, we’re on the bad path.

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